I am a long term buy and hold investor who focuses on dividend growth stocks

Friday, January 9, 2015

Robinhood Brokerage Review

Robinhood is a new broker, who lets customers purchase US stocks for no commission. Yes, that is true, customers pay no commissions when they purchase stocks using Robinhood. Unlike Loyal3, which also offers zero stock commissions, Robinhood offers access to almost all US traded stocks and the executions are real-time. With Loyal3, one has to wait for 2 – 3 business days before the investment is executed. However, Loyal3 is open to everyone right now, and has a lot of quality companies that allow purchases of fractional shares. All one has to do is have $10 to invest. Robinhood brokerage on the other hand is only available for a select number of customers today, doesn’t allow purchases of fractional shares, but executes trades right away. If this broker gets more established, I would put it on my list of best brokers for dividend investors.

- Zero commissions on US Stocks
- No account minimums
- No Inactivity Fees
- No Deposit/Withdrawal fees
- Trades are executed right away at good prices
- Investor assets under $500,000 are insured by the SIPC

The items I don’t like are:

- Only available for a limited number of people
- Has not existed long enough
- Only available using an app
- Does not allow opening IRA accounts
- Does not allow automatic dividend reinvestment
- Does not allow purchasing fractional shares

The service is not available for everyone yet, but will be launched sometime in early 2015. Currently, there are several hundred thousand customers who are in their waiting list. I was one of those users, but I moved up by signing up early, sending out invited, and sharing the information using social media. Thus, once the service becomes more widely available, I believe it could provide much lower fees to many beginning investors. To me, it would be much nicer to be able to allocate $2,000 - $3,000 into shares of 10 – 15 companies every month without paying commissions, rather than be limited to 2 – 3 investments for that month. Long-time readers know that I do not want to pay more than 0.50% in commissions on my purchase amount, and I also rarely sell.

So I signed up and last month was approved for trading. The email stated that I had to sign up within 72 hours of receipt, otherwise they would put me in the back of their waiting list. I opened the account, went to the usual forms of identification ( address, Social Security number etc), and then had to link my bank account information. I decided to put $100 in the application. Robinhood is SIPC insured, meaning that I am safe for amounts under $500,000 there, but it still a new broker. Therefore, I am not going to trust a material amount of money with it, until they prove to me that they are worthy of my dollars. After all, zero costs are fine, but it is also important that their system doesn’t crash when I want to make investments. It is also important that they keep my money secure, so that the chances of a hack attack are reduced. After I signed up, and account was approved, they prompted me to download their app on my smartphone.

The trades are executed only through a smartphone. While the sign up for the account was on my computer, the trading interface is only through that app on the phone. I know that this will be a very appealing feature for many younger readers, who can trade on the go. With commissions at zero, many investors will probably start investing more actively, which is usually a recipe for disaster for 90% of investors out there. I am relatively young myself (or at least consider myself that way), but I do not want to just be limited to an application on my phone when it comes to investments. Plus, if the app crashed or is being updated, I would not be able to make investments. For a buy and hold investor such as myself, I can afford to wait for a few days or minutes. But still, if I do not have access to a website where I can download statements ( the costs of a website shouldn’t be that high relative to that for an app), I am not going to invest much there. I cannot take that chance.

So how can a broker offer zero dollar trades? I believe that this broker will earn money by routing orders to exchanges that pay them fractions of a penny for order traffic. The broker will also earn money by potentially matching high frequency traders with your orders. The high frequency crowd essentially front-runs individual investors to earn a fraction of a penny per share, multiple times per day. As a long-term buy and hold investor, I do not care whether I buy Coca-Cola (KO) at $37/share or $37.01/share. The only thing that matters to me is that I do not pay more than 20 times earnings for Coca-Cola and that the earnings per share can grow over time, in order to justify valuation and generate more dividend growth in the future.

Another way that brokers earn money is by charging margin interest rates to their clients. Many like Schwab for example charge anywhere from 6% - 8% for margin loans (buying shares with borrowed money). Given the fact that money is so cheap today, this is a nice profit for the broker. The other way that brokers earn money is by lending out your shares to short-sellers, who pay them a short rebate. If Robinhood can somehow gain scale, and attract a lot of investors that trade often, they should do pretty well for themselves, once their fixed costs are met. In the business, a brokerage must meet steep regulation hurdles and costs, in order to handle client money.

The idea of zero commissions is very appealing nevertheless. If I were starting out today, and didn’t have a lot of money yet, I would use this application to build out a portfolio. I would watch out for other fees however. For example, it costs $50 to trade listed foreign stocks. It also costs $10 to make trades over the phone. Transferring securities out is another way where you will get hit by fees – there is a $75 outgoing ACAT transfer fee.

The idea of zero commission stock trades is not new. When I was first starting out with dividend investing, I used Zecco, which used to offer zero commission stock trades to investors. First they offered 40 free trades per month, then it was decreased to 10 trades/month. After that, the broker required a $2,500 minimum amount invested in order to be eligible for the free commissions, followed by an increase to $25,000, and then abolishing the free stock trades. Despite the increasing level of hoops however, for someone like me in the accumulation phase, it was helpful to be buying my first shares without incurring much in transaction costs. There are other companies like Wells Fargo and Merrill Edge which supposedly offer free trades every month to their customers. The problem is that there are just too many hoops to jump through. In the case of Merrill Edge, I have to have tens of thousands of dollars in a Bank of America account in order to qualify. The opportunity cost of $25,000 sitting in cash is higher than the $1 commission I pay at Interactive Brokers today.

I am going to keep a small amount of cash in Robinhood to test their platform. I bought a couple shares there, and the process was quick and efficient. Plus the prices I paid were fair. It was nice that I didn’t have to pay any commissions. Given the fact that this is a fairly new broker, that is untested, I am not going to put more than a few hundred bucks there. I have been using my broker Interactive Brokers as the main broker vehicle since the middle of 2014. I know that I pay $1/trade, which is more than $0/trade. In addition, for investors with less than $100,000 in assets there, Interactive assesses a $10 monthly fee. However I like the fact that my orders are directly executed on an exchange and that neither my broker nor a high frequency trader is trading against me on the order. I also like the fact that Interactive has been around for many years, is profitable, and very unlikely to go under and have my assets frozen for a period of time. I still keep under the SIPC limits there of course. It is very nice that I can buy shares cheaply at Interactive Brokers, and then transfer them to another broker that could have otherwise charged me $7 - $10/trade. It is also nice that Interactive Brokers charges around 1.50% on margin interest.

Either way, I am going to monitor Robinhood closely. In the future, once the broker becomes more established, I could start doing a more significant level of business there. Until then, I will keep my investing elsewhere.

Disclaimer

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